7 things you thought you knew about Bitcoin (but that are wrong)

Bitcoin has made headlines again yesterday, reaching an all-time trading high of more than £21. This is a significant development for the fairly new alternative currency, which started at Zero in 2009. Bitcoins has slowly and quietly become a global phenomenon which is featured prominently in the media, and has started to attract the special attention of global regulators.

So how exactly does Bitcoin work? Here are seven myths which describe what Bitcoin is, and – more importantly – what it not is.

Myth 1: Bitcoin is complicated to use

Bitcoin was created in 2009 as a safe and decentralised alternative means to pay for goods and services. Using bitcoins is very easy, by using a bitcoin wallet, which is basically an online account enabling users to buy and sell bitcoins against another currency. Bitcoins can also be exchanged through websites (so called bitcoin exchanges), physical banknotes and cash. Every Bitcoin transaction is sent through the entire Bitcoin network to verify the uniqueness of the used bitcoin, and to ensure that one bitcoin is not spend twice at the same time. This process takes around 10 minutes and is secure: even if one or several participants in the network were hacked, the confirmation process would still require others to verify the transaction.

Myth 2: Bitcoin is only accepted by online shops involved in illegal activity

Myth 3: Bitcoin is 100% safe

When making a transaction, the Bitcoin network checks the transaction history of that particular bitcoin against the records of a number of different nodes in the network. Only when these agree that the bitcoin is genuine, the actual transfer occurs. This P2P system can neither be hacked (because too many participants are involved) nor reveal the real identify of the bitcoin holder (because no bitcoin wallet account names are used in the verification process, just numbers and strings). However, as with any highly secure product, the attraction for people with knowledge of cryptography to have a go at breaking the system is immense – especially with a real monetary value of each bitcoin. There have been a number of incidents over the last years, resulting in legal action against exchanges when their clients’ Bitcoins were stolen. So the system is not 100% safe and there is a certain danger that bitcoins are being stolen. Which is similar in “real” currencies.

Myth 4: Everyone can create new Bitcoins

Whilst the first bitcoins were relatively easy to create to help spread the currency, the algorithm makes creating bitcoins increasingly difficult. Creating (or “mining”) your own bitcoins is possible, but this requires a processor power, storage – and patience (see photo).

You will have to invest quite a bit of money into hardware, and quite some time, if you would like to make some profit you can calculate here how long this would take.

Myth 5: Bitcoin’s value will decrease over time

Inflation is inherent to every major currency which is managed by one central organisation such as a Government. They can decide to print more money if needed, at any time. Every time this happens the individual denomination then becomes worth a bit less. With Bitcoins built-in 21 million cap however, there is no quantitative easing or inflation. At the same time however, the value of each Bitcoin fully depends on market demand and supply – so the value will increase and decrease over time.

Myth 6: Bitcoin is a sensible alternative investment

The majority of Bitcoin transactions are still done for speculative reasons, rather than buying goods online. Bitcoin has seen interest my many speculators, including City traders. However the value of Bitcoins fluctuates significantly, its value has increased from around £2 in November 2011 to over £20 in 2013. These fluctuations are higher than with any other traditional currency, making Bitcoin a very risky investment – which at the moment pays off. However as the currency is not linked to any economy or economic behaviour, future values are more or less impossible to predict.

Myth 7: Bitcoin is a real threat to real currencies

At the moment, Bitcoin’s current market capitalisation is ca USD 370 million. There are around 40 transactions every minute, with roughly 1,000 Bitcoins exchanged. This is decent, but can in no way compare to any major currency. Yet: At the moment nearly 11 million bitcoins have been created.

The Bitcoin algorithm limits the amount of available to 21 million bitcoins, which are divided into smaller units called satoshis. The maximum is 2,100,000,000,000,000 Bitcoin elements which can ever be around. The value of each bitcoin unit being freely defined only by its users, without any central interference. So even if Bitcoin will never replace a traditional major currency, this maximum amount is high enough to create an attractive alternative.

A few points are still open for debate – providing a service in exchange for bitcoins circumvents the tax system, as an example. And is Bitcoin actually real money, as you can buy real products, and should Bitcoin exchanges therefore be regulated? Every further Bitcoin milestone will make sure that the discussion continues.

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About the author

Robert has more than 12 years of experience in the international technology, telecommunications and financial markets. He advises businesses of all sizes on their communications and marketing strategies, and has worked with companies including Cisco Systems, EDS, the UK Payments Council, Interoute, Clear2Pay, giropay and MACH. His focus areas include payments technology, company funding/VC and financial technology. You can follow him on Twitter.